Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman met in mid-June on the sidelines of a World Cup game in Moscow to discuss oil prices and diplomacy ahead of the recent OPEC meeting. It was the latest effort to wrest control of oil prices that began with the historic Vienna production cuts in 2016 that rescued the oil market, and the most recent in a long line of attempts to control the oil price cycle.
The production cuts worked. The OPEC members and several largest producers, including Russia and Mexico, agreed in late 2016 to curb oil production by 1.8 million B/D to reduce the supply glut that had sent prices plummeting and caused massive layoffs throughout the industry. Compliance was not only good, but better than expected. Some countries cut supply even more than they agreed, and Venezuelan output dropped sharply because of that country’s economic crisis, which brought the market back in balance. The production cuts totaled almost 2.5 million B/D, according to the International Energy Agency (IEA).
The extent of the cuts has led some, including the IEA, to fear that the market could soon be in short supply, sending prices sharply higher, and continuing the cycle of sharp shocks to the market. To them, oil prices in the $60–70 bbl range would be ideal, encouraging new production to replace declining reserves without disrupting demand growth. The oil market has tightened quickly, which should lead to output increases from major producers this year and next.
Common phrases in the industry this year are “cautious optimism” about prices and “capital discipline.” But oil price cyclicality appears inevitable. The long-term nature of the business that requires years to develop new production, along with reliance on lagging indicators and the relative price inelasticity of consumption, underlies the difficulty of balancing supply and demand. Since 2014, rebalancing the oil market has meant cutting production and reducing inventories; for the rest of this year and 2019, it will mean increasing supply to prevent prices from rising too quickly.
One source of supply that may help is the Permian Basin, which has seen remarkable growth during the downturn, and could act as a swing producer and a major oil exporter. A new report from IHS Markit forecasts that Permian production will rise by almost 3 million B/D to 5.4 million B/D by 2023. Production from the Permian by itself would be greater than any OPEC country except Saudi Arabia and the additional output would be more than the production of Kuwait, the report said. Permian output was less than 1 million B/D in 2010. One thing that could derail this predicted increase is strains on infrastructure. Already, logistical bottlenecks in pipelines and trucking have occurred, causing some production to be deferred to next year.
